Are You a High Earner? One Quick Path to Lowering Your 2017 Taxes

If you're a high earner, you're probably looking for ways to make your life easier and your taxes lower. The good news is that 2017 may just bring about an answer to both your quandaries. What is that answer? Forming a pass-through entity. Here's the rundown on this potentially tax-saving option.

What Is It? A pass-through entity is a simple business structure made up of sole proprietorships, partnerships, Limited Liability Companies, and S Corporations that do not pay a direct corporate income tax. Instead, these businesses "pass on" their profits to the owners of the business, who then pay the standard income tax rates on their share of the profits. 

How Can It Help? Currently, pass-through entities' profits are taxed at the regular rate of each individual taxpayer who owes the tax. If you earn a lot of money, this means you could be paying up to 39.6% tax on this money. Plus, it is generally subject to the additional Self-Employment Tax of 15.3% to cover Social Security and Medicare contributions. However, tax plans being considered by the new presidential administration and Congress indicates that the income tax rate for a pass-through entity may be changed to a maximum of 15% income tax rate. This can add up to significant savings on such income.

What Should You Do? If you're being paid as an employee, assess what effective tax rate you're currently paying (Line 63 of Form 1040 divided by your Adjusted Gross Income). If this percentage is higher than 22.65% (15% new tax rate plus half of the Self Employment Tax), you may benefit from ceasing to be an employee and instead becoming an independent business or sole proprietorship. If you're unsure of how this new type of business taxation would affect your bottom line, work with a qualified accountant before making any decisions. 

How Else Can It Help? If your taxes would be reduced by forming a pass-through entity instead of working as an employee, you may also be free to subcontract some of your work or take advantage of telecommuting. Independent contractors, unlike employees, have great control over how, when, and where they complete work for a company. This means that you may be able to do things like set your own hours, hire help, and deduct more expenses related to your work. Any of these changes may help reduce both your costs and your stress level. 

What Should You Know? It's a good idea to consult with someone experienced in taxation and business law to understand the risks of becoming an independent contractor. These risks include a lack of workers compensation and labor protections, employer costs (if hiring help) and taxes, few business expenses to deduct, and being subject to state business law.

The answer of how best to take advantage of proposed changes in income taxes and business taxation is something only you can answer. But, if you're willing to think outside the box, you may find that you can improve your finances and your life by forming a pass-through entity. 


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